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Monday, November 16, 2015

Islamic State's Oil: An Attempt at Legitimacy

Just three days after horrific attacks in Paris that leave over 120 dead on a Friday night, military responses intensify as France and coalition-lead forces have revenge on their minds. Consequently, dozens of air raids over some of the Islamic State strongholds occurred early today.Among the targets, spread over lands in Syria and Iraq, French bombers leveled the unofficial capital of the terrorist organization in Raqqa. While many military bases and industrial structures were successfully hit, a news website associated with ISIS reported that there were no casualties from the attacks although that is most likely not the case. These attacks introduced the conflict to more aggressive plans from Western forces that include President Obama's "amplification: of air campaigns as well as special operations that will be employed strategically in order to continue towards the objective of containing the Islamic State and the organization's desire to increase the amount of terrorist attacks in Europe and the United States. For that reason, coalition air forces teamed up to destroy key financial targets that provide revenue streams to terrorist activities of the Islamic State. These targets consisted of major oil fields that have been taken over by ISIS ground forces. After being overrun, the Islamic State makes these wells operational by staffing them with petroleum engineers and workers that vary out the production processes. According to the group's so-called "finance ministry," reports have counted about 275 engineers and 1,107 workers operating on 253 wells that have been taken over with around 160 deemed operational.

As an economic force, the Islamic State has provided no credence to its ability to bully financially even though they have crippled crude oil production from two of the (potentially) most productive Middle Eastern states. Iraq and Syria have suffered from the encroachment of the radical organization, and their forces have been pushed back forcing to concede land and these valuable oil resources. Iraq may feel more troubled by this loss because of its recent increase in production that has become endangered by Islamic State threats. Syria, on the other hand, has experienced a consistent decrease in its production as the civil war and ISIS conflicts continue to brew. While these nations have been hurt be conceding land and oil, the Islamic State has managed to add almost $50 million a month to its coffers with successful expansion supporting the rampant smuggling of petroleum in the region. Military officials estimate that purchases from smugglers moving oil around the region have been buying the oil for a cheap $35 a barrel with some purchases ranging as low as $10 a barrel. These prices sharply undercut the marketplace and could have potential supply and demand effects if these industrial capacities were to grow. Current approximations of ISIS production land around 40,000-50,000 barrels a day, with about 30,000 from Syria and 10,000-20,000 from Iraq. Below are some very rough estimations of the potential selling prices per barrel based on an upper and lower bound described above. These numbers are based on the presumption that IS will seek to get the most out of its oil sales as well as the necessity to stay below market prices of just over $40 in order to incentivized buying from a stigmatized source.

Once again, these guesses are very rough and are based on estimations themselves, but I think they may provide insight into the possibilities of oil realization for the Islamic State. With these numbers, a projected average price per sale of barrel rests at $24.25 a barrel. This guess takes into account that at least 50% of oil production is being sold in the range from $25-35. Lower prices are considered and counted so heavily because buyers are in the position to negotiate as ISIS is a dangerous entity with which to do business. Using this average price, one can calculate an amount of production which could represent that of the current Islamic State (before air strikes). Many articles propose revenues of $40-50 million a month for a total of $450-500 million a year, very similar to a moderately sized U.S. oil and gas production firm. My calculations will take ISIS's reports of $46.7 million of revenue for September. Using this statistic, estimations of $30 million for the first three months, $38 million for the next three, and an average of $45 million for the last six months as a potential revenue stream for 2015 (once again, given that air strikes did not change anything). In the end, my estimates are $39.5 million a month with a yearly total of $474 million, a very rough number reflecting what has been read in various articles as well as considerations to the organization's growth. These calculations provide us with a yearly production of 19.55 million barrels and a daily count of about 53,500 a day which top the upper approximations that I have observed in various publications. Even with errors of 5,000 barrels on either side, Islamic State remains at about 50,000 barrels with the likely potential to produce more by operating currently inactive wells. Stepping back and looking at the current market conditions, does ISIS cheap oil play into the supply and demand equation? Not exactly, but it could imply something else. Think about it this way. Every barrel that is produced by a friendly or neutral Arab country is accounted for and sold on the market or processed domestically (for the most part), but oil fields that are taken over by the expanding forces of ISIS are labelled as a target with intent to cripple their finances. As oil production is taken over, it is automatically assigned a higher probability of being destroyed. For example, if ISIS were to launch an enormous ground offensive and occupy all of Iraqi oil infrastructure, crude prices would skyrocket, not because supply has suddenly vanished, but because the coalition forces are now out to destroy it. Market psychology played beautifully into the hands of paranoid doomsday oil economists during the invasion of Kuwait and the Iraqi wars even though small amounts of production were likely to be affected. We have already seen this effect in today's trading session as energy shares lead gains. From a military standpoint, I think bombing ISIS's oilfields is one of the best strategies at this point with too much opposition to a "boots on the ground" approach. Petroleum products account for about 65%. according to WSJ, of Islamic State revenue at this point, and the group shows no desire to relax this strategy of attaining wealth. With the crippling of financial flows, the economic devastation will effectively discredit the organization as a productive unit operating towards their ultimate goals. One can already observe the desperation to seem "legitimate" with the establishment of a "finance ministry" and the desire to infiltrate and adopt a sustainable financial system. The Islamic State is more advanced than al-Qaeda in that it wants to become a viable force with more than just haphazard terrorist attacks seeking to inspire fear. They want to build a network. Because of this interesting new nation-terrorist group hybrid, the Western world should consider this new type of threat and how to deal with it. Even though it seeks to be legitimate, the Islamic State will not create any market disturbances in the global economy because of successful financial undermining through the bombing of oil fields. These strategies should be commended and continued until the capacity to produce oil in ISIS territory is either disabled or destroyed completely. On top of that, smugglers and demand for the oil should be quarantined and subsequently choked off until no oil in that region will be able to find a home. Turkey has already started to crack down on smuggling with thousands of cases combatted and resolved. There is no doubt, though, that an Islamic State with oil is bad news. With Iraqi production reaching almost 3.5 million barrels a day in 2014, the radical group has plenty of capacity to attack and reallocate. These economic threats of ISIS legitimacy should be resolved and, ultimately, extirpated.